Total Cost of Goods Manufactured 20,000 Total Goods Available for Sale 25,000 Ending Finished Goods (8,000) Cost of Goods Sold $17,000 Why is it Important to Understand Cost Behaviour? Up to this point in our study of costs, we have focused on the financial statements where things like separation of costs between period and product were important. We're now going to take a more analytical approach: Examining our costs to see if they can tell us anything about our business. This is where Management Accounting gets interesting! Understanding cost behaviour means understanding how costs change in relation to production or activity levels. To avoid surprises, it is critical that Managers understand how costs will react before a change is implemented. Fixed and Variable Costs We can separate all of our costs into two broad categories: Fixed or Variable. As a rule, Direct Materials and Direct Labour are always variable. Manufacturing Overhead can be either fixed or variable depending on the nature of the cost.
Fixed Fixed costs remain the same regardless of the level of production. Using our potato chip plant from the last module, fixed costs could include salaries of the production Supervisor and Maintenance worker, the rent for the building and property taxes. None of these change on a weekly or monthly basis. Variable Variable costs will change as the level of production changes. Using our potato chip plant from the last module, variable costs could include: utilities, cleaning supplies and shipping expenses. For all of these, the longer we operate our plant, the higher the total costs will be. It is a fairly broad generalization to say that a cost is either completely fixed or completely variable. In reality, many costs are a mixture of both. Take electricity costs for example: There is always going to be a certain base level of electricity used in a factory regardless of how many shifts we run (an argument for a portion of the electricity to be fixed). However, the more shifts we run and machines we operate, the higher that electricity bill is going to be (a variable cost). For the purposes of this course, please disregard the "Mixed" option and identify costs as either Fixed or Variable depending on what would represent the most significant component. In the case of electricity - the variable component would be a far larger proportion of the total bill. Electricity is a variable cost. Fixed Costs As long as the production levels remain within the capacity of the existing facility, the rent expense will not change. It's important to understand that while fixed costs stay the same regardless of the level of production, they will decrease on a per unit basis as production level increases. The graph below shows the relationship between units of output and the fixed rent expense:
Notice that even though production levels increase from 1,500 units to over 5,000 units, the rent expense remains fixed at $2,000.
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- Summer '18
- Goods Sold, Goods Manufactured, cost classifications